If an investor’s self-directed IRA does not have the cash for the full purchase price of a rental property, the IRA can get a non-recourse loan to cover the remaining amount. Debt-leverage allows an investor to buy an investment property worth two or three times more than their current IRA balance; all while allowing a tenant to pay off the IRA’s debts through rental income (which could also provide additional cash flow).
Investors can combine the benefits of a loan with the tax-deferred or tax-free income rules associated with their IRA account. Although the outstanding debt-leveraged percentage of an IRA’s net profits are subject to unrelated business income tax (UBIT), utilizing a loan for a real estate investment may ultimately allow retirement investors to realize higher profits than they could have without a loan. An IRA operates similarly to any investor: it receives rent and pays debt service.
Regarding the long-term benefits of a loan in a real estate IRA, once the account pays off the IRA’s loan and their debt ratio calculates to zero (by averaging the last twelve months), they will no longer have to pay UBIT on any percentage of the IRA’s profits. The investor can then sell the property without having to pay UBIT on the profits from the sale. Because the property was bought with a tax-deferred or tax-free IRA account, there are no capital gains taxes on any of the real estate IRA’s profits.
Depreciation provides investors with tax breaks each year throughout the life of the investment property while they still have debt. When an investor purchases property outside of an IRA, they are eventually taxed on the depreciation of the property upon sale of the home. However, in an IRA, once the debt ratio of the investment property’s loan calculates to zero (over the last twelve months), the investor no longer has to pay tax on the depreciation upon the sale of the property. Keeping the benefits of yearly depreciation deferral without having to pay tax on that deferral can provide investors with a big advantage.
To learn more about utilizing a loan for your real estate IRA, feel free to contact New Direction today.